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TORONTO — Weakening economic conditions weighed on Canadian banks as they began to report second quarter results Wednesday.

Both BMO Financial Group and Bank of Nova Scotia reported higher expenses, more money set aside for bad loans, and slowing loan growth in Canada that led both to earn less than they did a year ago and fall short of analysts' expectations. 

BMO chief executive Darryl White characterized it as a "shifting environment" that is putting pressure on revenue growth.

"The impact of persistent inflation, rising rates, a slowing global economy and an increasing deposit competition on the industry has accelerated. We're not immune to these market forces," he said on an analyst call. 

His comments came as the bank reported a profit of $1.06 billion, down 78 per cent from a profit of $4.76 billion a year ago, due in part to adjustments related to its deal to buy Bank of the West. Revenue for the quarter totalled $8.44 billion, down from $9.32 billion last year. 

Scotiabank chief executive Scott Thomson said the quarter was marked by "challenging market conditions" as the bank reported net income down 21 per cent from a year earlier to $2.16 billion. Scotiabank's revenue totalled $7.93 billion, down from $7.94 billion in the same quarter last year.

The results came after a quarter marked by turmoil in the U.S. banking system as several major banks, starting with Silicon Valley Bank, became unstable enough for regulators to force a sale. 

The banking crisis was created in part by rapidly rising interest rates that have also put pressure on households carrying mortgages, but clients are so far largely managing to keep up with payments, the banks said. 

"Our customers are managing through this period of heightened interest rates by making trade-offs," said Scotiabank chief risk officer Phil Thomas on an earnings call.

"For example, discretionary spending such as retail spending and entertainment is down 10 per cent year-over-year for our variable rate customers."

He said delinquency rates on loans are trending up modestly and that the bank expects provisions for bad loans to stay elevated for the year, but that he's comfortable with how the bank is positioned for the economic cycles ahead.

Borrowers are leaning on savings accumulated during the pandemic to make higher loan payments, said Thomas. 

"They have been drawing down on that payment buffer. They still have more deposits in their account than they did pre-pandemic, but we're starting to see those deposits run off as payment levels increase."

Credit trends at BMO are beginning to normalize from historically low levels but credit performance remains strong, said White.

And while Canadians are still paying their mortgages, there were fewer people taking out loans in the quarter.

BMO reported overall Canadian loan growth of 0.9 per cent from the previous quarter, driven by credit cards and commercial loans as personal and business banking was flat, while overall loans were up 9.8 per cent from a year earlier.

Scotiabank reported lending volume growth of 0.2 per cent from the previous quarter, and up 6.5 per cent from a year earlier. 

Both banks tried to assure investors that they don't see significant risks from their commercial lending portfolios, as record office vacancies in many cities raise concerns about looming devaluations in the sector.

BMO chief risk officer Piyush Agrawal said office loans make up only about one per cent of the bank's overall portfolio, and that so far effects have been muted even if there could be a bigger hit ahead.

"In our stress test, we don't see any immediate worries now, but we know there is blood in the water. There will be impacts as rates rise."

BMO, which closed its US$16.3-billion Bank of the West deal in the quarter, said the failure of some U.S. banks created increased volatility and that overall the bank is taking a more careful stance and setting aside more money.

"As we look ahead, we are cautious about the economic environment," said Agrawal.

BMO's provision for credit losses amounted to $1.02 billion in the quarter, up from $50 million a year earlier.

Scotiabank's provisions totalled $709 million, up from $219 million a year ago.

Inflation also weighed in results as BMO reported expenses up 50 per cent in the quarter from last year, with costs associated with the Bank of the West acquisition making up the bulk of the jump, while Scotiabank reported expenses were up 10 per cent in the quarter from a year earlier. 

The combination of stresses, which also included slower trading revenue compared with the previous quarter, led to profit misses from both banks. 

BMO's adjusted earnings per diluted share came in at $2.93, down from $3.23 last year and below analyst expectations of $3.19 per share, according to estimates compiled by financial markets data firm Refinitiv.

Scotiabank says it earned an adjusted $1.70 per diluted share in its latest quarter, down from $2.18  in the same quarter last year and below the average analyst expectation for $1.78 per share according Refinitiv.

The results point to the start of the tighter market conditions that have been much anticipated, said Barclays analyst John Aiken in a note.

"Headline misses from BMO and Scotia, weighed by higher provisions, slower top-line growth, an increase in expenses, and weaker capital markets beset by lower trading revenues, suggest the challenging operating environment may have begun."

This report by The Canadian Press was first published May 24, 2023.

Companies in this story: (TSX:BMO; TSX:BNS)

Ian Bickis, The Canadian Press